Speaking at a Brussels conference back in April 2011, Eurogroup
President Jean Claude Juncker notably stated during a panel
discussion that "when it becomes serious, you have to lie." He was
referring to situations where the act of "pre-indicating" decisions
on eurozone policy could fuel speculation that could harm the
markets and undermine their policies' effectiveness.1
Everyone understands that the authorities sometimes lie in order to
promote calm in the markets, but it was unexpected to hear such a
high-level official actually admit to doing so. They're
not supposed to admit that they lie. It is also somewhat
disconcerting given the fact that virtually every economic event we
have lived through since that time can very easily be described as
"serious". Bank runs in Spain and Greece are indeed "serious", as
is the weak economic data now emanating from Europe, the US and
China. Should we assume that the authorities have been lying more
frequently than usual over the past year?
When former Fed Chairman Alan Greenspan denied and down-played
the US housing bubble back in 2004 and 2005, the market didn't
realize how wrong he was until the bubble burst in 2007-2008. The
same applies to the current Fed Chairman, Ben Bernanke, when he
famously told US Congress in March of 2007 that "At this juncture…
the impact on the broader economy and financial markets of the
problems in the subprime markets seems likely to be
contained."2 They weren't necessarily lying, per se,
they just underestimated the seriousness of the problem. At this
point in the crisis, however, we are hard pressed to believe
anything uttered by a central planner or financial authority
figure. How many times have we heard that the eurozone crisis has
been solved? And how many times have we heard officials flat out
lie while the roof is burning over their heads?
Back in March, following the successful €530 billion launch of
LTRO II, European Central Bank President Mario Draghi assured
Germany's Bild Newspaper that "The worst is over… the situation is
stabilizing."3 The situation certainly did stabilize…
for about a month. And then the bank runs started up again and
sovereign bond yields spiked. Draghi has since treaded the awkward
plank of promoting calm while slipping out enough bad news to
ensure the eurocrats stay on their toes. As ING economist Carsten
Brzeski aptly described at an ECB press conference in early June,
"Listening to the ECB's macro-economic assessment was a bit like
listening to whistles in the dark… It looks as if they are becoming
increasingly worried, but do not want to show it."4 And
the situation has now deteriorated to the point where Draghi can't
possibly show it. Although Draghi does now warn of "serious
downside risks" in the eurozone, he maintains that they are, in his
words, "mostly to do with heightened uncertainty".5 Of
course they are, Mario. Europe's issues are simply due to a vague
feeling of unease felt among the EU populace. They have nothing to
do with fact that the EU banking system is on the verge of
collapsing in on itself.
When Prime Minister Mariano Rajoy assured the Spanish press that
"There will be no rescue of the Spanish banking sector" on May
28th, the Spanish government announced a $125 billion bailout for
its banks a mere two weeks later.6 This
apparent deceit was not lost on the Spanish left, who were quick to
dub him "Lying Rajoy". But Mr. Rajoy didn't seem phased in the
least. As the Guardian writes, "Even when the outpouring of outrage
forced Rajoy to call a hasty press conference the next day, he
still refused to use the word "bailout" - or any other word for
that matter - and referred mysteriously to "what happened on
Saturday". He went as far as to say that Spain's emergency had been
"resolved" ("thanks to my pressure", he said). He then took a plane
to Poland to watch the national football team play ("the players
deserve my presence")."7 Sound credible to you?
Then there are the bankers. Back in April, JP Morgan CEO Jamie
Dimon blithely dismissed media reports as a "tempest in a teapot"
that referred to massively outsized derivative positions held by
the bank's traders in the Chief Investment Office in London. That
"tempest" was soon revealed to have resulted in a $2 billion
trading loss for the bank roughly four weeks later. In testimony
before the Senate Banking Committee this past week, Dimon explained
that "This particular synthetic credit portfolio was intended to
earn a lot of revenue if there was a crisis. I consider that a
hedge."8 He went on to add that regulators "can't stop
something like this from happening. It was purely a management
mistake."9 That's just wonderful. Can we expect more
'mistakes' of this nature in the coming months given JP Morgan's
estimated $70 trillion in derivatives exposure? And will the US
taxpayer willingly bail out JP Morgan when it does? Everyone knows
the derivatives position wasn't a hedge - but what else is Dimon
going to say? That JP Morgan is making reckless derivatives bets
overseas with other people's money that's backstopped by the US
government? Credibility is leaving the system.
There is certainly a sense that the authorities can no longer be
candid about this ongoing crisis, even if they want to be. On June
11th Austria's finance minister, Maria Fekter, opined in a
television interview that, "Italy has to work its way out of its
economic dilemma of very high deficits and debt, but of course it
may be that, given the high rates Italy pays to refinance on
markets, they too will need support."10 Her honesty sent
Italian bond yields soaring and earned her some harsh criticism
from eurozone officials, including Italian Prime Minister Mario
Monti. As one eurozone official stated, "The problem is that this
is market sensitive… It's one thing if journalists write this but
quite another if a eurozone minister says it. Verbal discipline is
very important but she doesn't seem to get that."11 See
no evil, hear no evil… and speak no evil. That's the way forward
for the eurozone elites.
We have no doubt that everyone is tired of bad news, but we are
compelled to review the facts: Europe is currently experiencing
severe bank runs, budgets in virtually every western country on the
planet are out of control, the banking system is running excessive
leverage and risk, the costs of servicing the ever-increasing
amounts of government debt are rising rapidly, and the economies of
Europe, Asia and the United States are slowing down or are in full
contraction. There's no sugar coating it and we have to stop
listening to politicians and central planners who continue to
downplay, obfuscate and flat out lie about the current economic
reality. Stop listening to them.
NOTHING the central bankers have done up to this point has
WORKED. All efforts have simply been aimed at keeping the financial
system from imploding. QE I and II haven't worked. LTRO I and II
haven't worked, and the most recent central bank initiatives are
not even producing short-term benefits at this stage of the crisis.
Just take Spain, for example. Following Rajoy's announcement of the
$125 billion bailout loan for the Spanish banks on June 10th,
Spanish bond yields were trading back over 7% one week later - the
same yield level at which other eurozone countries have been forced
to ask for further international aid.12 The market still
doesn't even know what entity is going to pay the $125 billion, let
alone when the funds will actually be released or whether the
Spanish government will have to count it as part of its national
debt. Spain is the fourth largest economy in the eurozone and
larger than the previously bailedout Greece, Ireland and Portugal
combined. At this point, it's not even clear if the ECB will be
allowed to bail out a country of Spain's size, let alone Italy,
which is now asking the ECB to use bailout funds to buy
its sovereign bonds.13
The situation in Europe is becoming an exercise in futility. The
positive effects of LTRO I and II, which combined pumped in over €1
trillion into European banks back in December 2011 and February
2012, have now been completely erased by the recent bank runs in
Spain. Of the €523 billion released in LTRO II, roughly €200
billion was taken by Spanish banks.14 Of that amount,
roughly €61 billion was estimated to have been reinvested back into
Spanish sovereign bonds, which temporarily helped Spanish bond
yields drop back to a sustainable level below 5.5%. Fast forward to
today, and despite the LTRO infusions, the Spanish banks are all
broke again after their underlying depositors withdrew billions
over the past six weeks. The only liquid assets Spanish banks still
own that they can sell to raise euros just happen to be government
bonds… hence the rise in Spanish yields. So in essence, the entire
benefit of the LTRO, which was a clever way of replenishing Spanish
bank capital AND helping calm sovereign bond yields, has been
completely reversed in roughly 14 weeks. It's as we've said before
- it's not a sovereign problem, it's a banking problem. This is why
Spanish Prime Minister Rajoy is now pleading for help "to break the
link between risk in the banking sector and sovereign
risk."15 Without a healthy sovereign bond market,
peripheral eurozone countries simply have no way of supporting
their bloated and insolvent banks.
The smart money is finally waking up to the dimension of the
problem here and realizing that it's really a banking issue.
Deposit flight has revealed the vulnerability of the European
banking system: when depositors make withdrawals, the only assets
the banks can sell to raise liquidity are sovereign bonds, which
creates the vicious downward spiral that up to this point has
always resulted in some form of central bank bailout. Many eurozone
authorities still have trouble understanding this. As Spanish
Economy Minister, Luis de Guindos, recently stated to reporters at
the G20 Summit, "We think… that the way markets are penalizing
Spain today does not reflect the efforts we have made or the growth
potential of the economy… Spain is a solvent country and a country
which has a capacity to grow."16 Every country has the
capacity to grow. Not every country has a domestic banking system
that has already borrowed €316 billion from the ECB so far this
year (pre the most recently announced bailout), and needs to
rollover roughly €600 billion in bank debt in 2012.17
That may be why the markets are reacting the way they are.
If you want to know what's really going on, listen to the
executives of companies that actually produce and sell things. On
May 24, Tiffany & Co cut its fiscal-year sales and profit
forecasts blaming "slowing growth in key markets like China and
weakness in the United States as shoppers think twice about
spending on high-end jewelry."18 On June 8th, McDonald's
surprised the market with lower than expected same-store sales
growth in May, following a lacklustre April sales report that the
company stated was "largely due to underperformance in the United
States, where consumers continue to seek out very low-priced
food."19, 20 On June 13th, Nucor Corp., the
largest U.S. steelmaker by market value warned that its
second-quarter profit will miss its previous guidance after a
"surge" in imports undermined prices and "political and economic
uncertainty affect buyers' confidence".21 On June 20th,
Proctor and Gamble lowered its fourth quarter guidance and profit
forecast for 2012. Factors that drove the company's challenges
included "slow-to-no GDP growth in developed markets", high
unemployment levels, significant commodity cost increases and
"highly volatile foreign exchange rates".22 Other
companies that have recently lowered guidance include Danone,
Nestle, Unilever, Cisco Systems, Dell, Lowe's, and Fedex. It's ugly
out there, and many companies are politely warning the market about
the type of environment they foresee ahead in both the US and
abroad.
To give you a hint of how bad it is in Europe today, the most
recent retail sales out of Netherlands showed a decline of 8.7%
year-over-year in April.23 In Spain, retail sales fell
9.8% year-on-year in April, which was 6% greater than the revised
drop of 3.8% in March.24 Declines of this magnitude are
not normal occurrences and signal a significant shift in spending
within those countries. We fear this is a sign of things to come
within the broader Eurozone, which will only serve to complicate an
already dire situation that much more.
The G6 central banks are out of conventional tools to solve this
financial crisis. With interest rates at zero, and the thought of
further stimulus rendered politically unpalatable for the time
being, we cannot see any positive solutions to this problem other
than debt repudiation. We continue to note the contrast between the
reporting companies who by law cannot lie about their fiscal
realities, versus the central planners who admit that they MUST lie
to preserve calm and control. We'll leave it to you to
decide whose version of the truth you want to believe.
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